Financial Review

Stormy Weather

Sinclair Noe — April 3, 2017

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DOW – 13 = 10,650
SPX – 3 = 2358
NAS – 17 = 5894
RUT – 16 = 1369
10 Y – .05 = 2.34%
OIL – .33 = 50.27
GOLD + 3.80 = 1254.00

The Institute for Supply Management (ISM) said its index of national factory activity slipped to a reading of 57.2 last month from 57.7 in February, which was the highest since August 2014. A reading above 50 indicates an expansion in manufacturing, which accounts for about 12 percent of the U.S. economy.

The U.S. Markit manufacturing purchasing manager’s index fell to 53.3 in March from 54.2 the previous month.

In a separate report, the Commerce Department said construction spending increased 0.8 percent to $1.19 trillion in February. That was the highest level since April 2006 and followed an upwardly revised 0.4 percent drop in January. Construction spending increased 3.0 percent from a year ago.

In February, private construction spending rose 0.8 percent to its highest level since May 2006 after being unchanged in January. Spending on residential construction surged 1.8 percent to its highest level since July 2007.

Investment in home-building has now increased for five straight months. Spending on private nonresidential structures fell 0.3 percent in February, declining for a second consecutive month.

The yield on the 10-year Treasury note fell 5 basis points to 2.34%. Over the first quarter, the yield curve became flatter, meaning the difference of rates between short-term bonds and long-term bonds narrowed, signaling concern over the economic outlook.

Among Federal Reserve speakers, Philadelphia Fed President Patrick Harker reiterated that he still backs two more rate hikes this year. Richmond Fed President Jeffrey Lacker is scheduled later this evening. The big event on the economic calendar this week is the Jobs Report on Friday.

After 238,000 people were hired in January and 235,000 in February, some analysts are looking for a pullback in hiring, possibly a number below 200,000, simply because the economy can’t keep up that kind of hiring pace nearly eight years into a recovery in which employment has grown by nearly 15 million jobs.

Senate Democrats appear to have enough votes to block Neil Gorsuch’s confirmation to the U.S. Supreme Court under current rules, a move that may lead to a unilateral rule change by Republicans known as the “nuclear option”.

While the GOP controls the Senate 52-48, current rules require 60 votes to move a high court nomination toward a final vote. Democrats say they have 41 votes to oppose advancing the nomination. Senate Majority Leader Mitch McConnell has guaranteed that the Senate will confirm the judge, a hint that the GOP is prepared to force a rule change this week.

The rule change could happen Wednesday with a full vote on Friday. Gorsuch’s confirmation would give the court five Republican-appointed justices, restoring a majority that had been in place for almost half a century before the February 2016 death of Justice Antonin Scalia.

Brexit could disrupt millions of expats’ lives. The more than 3 million EU nationals who live in Britain and the almost 1 million British citizens who live in other EU countries face uncertainty. With the free movement of citizens—a basic tenet of EU law—curtailed or restricted, theoretically they could see bank accounts closed, employment terminated or rental agreements revoked—not to mention deportation.

Passenger car sales dropped last month even as automakers offered some very juicy discounts. Ford suffered the biggest loss with a 7.5 percent drop in sales, followed by Fiat Chrysler at 5 percent, Toyota at 2 percent and Honda at just under 1 percent. Nissan sales were up over 3 percent, Volkswagen’s rose just under 3 percent and GM posted an increase of just under 2 percent.

The LMC Automotive consulting firm said incentives hit a March record, averaging $3,768 per vehicle and the highest amount since March of 2009. In addition, cars and trucks are sitting on dealer lots for an average of 70 days, the highest level for any month since July of 2009 during the sharp economic downturn.

Even some truck and SUV inventories are starting to climb. Ford, which saw a 24 percent decline in car sales, executives were happy with monthly numbers largely because of a 10 percent increase in sales of the F-Series pickup.

Tesla said it delivered a record 25,418 vehicles in the quarter ended March, a 69-percent increase from last year. Tesla shares climbed about 6%, giving Tesla a market capitalization of $48 billion – surpassing Ford Motor’s $45 billion value and just below General Motor’s value of $51 billion. Tesla sold about 40,697 vehicles in the U.S. last year. Ford delivers that many F-Series trucks about every three weeks.

The Tesla story is not about past year performance but growth potential. Ten years from now it will be difficult to buy a new gas powered vehicle. The future is electric; something Ford and GM have failed to fully embrace. Still, there are doubters.

Short interest in Tesla has risen to 29 percent of its free float from a 52-week low of 20 percent in mid-October, even as Tesla shares have jumped nearly 40% since the start of the year – meaning short sellers have lost more than $2.2 billion in the first quarter, at least on paper. Today Elon Musk tweeted: “Stormy weather in Shortville …”

Looking ahead, Tesla will introduce the Model 3, with a more realistic price of around $35,000; they expect to produce 500,000 a year by 2018. But Tesla is more than a car company. It’s a vertically integrated energy company that also makes vehicles.

Tesla plans to transform from its original state as a small, financially precarious manufacturer of luxury electric cars to the world’s dominant supplier of clean, autonomous transport, and an electricity source for millions of businesses and homes. Tesla can start to deliver on that promise by combining the solar energy firm SolarCity, its massive lithium-ion battery plants, a growing number of retail stores, and expanding commercial and residential energy storage business.

Tesla’s theory goes that it can innovate faster, engineer a seamless user experience and reduce costs through economies of scale. As a one-stop shop for clean energy and mobility at work, home and on the road, Musk has mused before that Tesla could be the world’s first $1 trillion company one day.

If Tesla succeeds, it will find itself as a major global player in two of the world’s largest markets: energy and transportation.  Of course, a lot needs to happen first, and Tesla will likely weather a few storms along the way.

Companies that provide oil and gas drilling services had to lower prices for their clients during the most recent oil crash. Some oil-field services providers lowered prices for offshore drilling by as much as 50%, toward levels that would have made their businesses unprofitable, according to Reuters.

Oil-field services giants like Baker Hughes and Halliburton lost pricing power because the oil crash hurt their clients’ revenue. That fiscal pain led clients to be more willing to find the cheapest driller. Separate from the oil crash, there has been a structural decline in the average cost of drilling for oil for the past few years.

Per a report from the Energy Information Administration last March, costs per well increased from 2006 through 2012 — a time of rapid growth in US drilling activity. But average costs have fallen since 2012 partly because of more efficient technology. That does not mean oil will trade much lower, but it likely helps define a trading range of about $40 to $60 a barrel.

The New York Federal Reserve announced that in 2017 total household debt will reach its previous peak of $12.68 trillion, which it reached in the third quarter of 2008. It’s already close: Total household debt in the fourth quarter of 2016 was nearly as high, at $12.58 trillion.

Compared with 2008, fewer borrowers have housing-related debt — including their first mortgages, or home equity lines of credit — and instead more have taken on auto and student loans. Although housing debt has decreased since 2008, mortgages still make up the bulk of the debt total, at 67%.

In 2016, borrowers with $100,000 in student loans or more make up just 5% of borrowers, but account for about 30% of total outstanding student debt. What’s more, these borrowers appear to be struggling more than they have in recent years.

But the default rates have spiked over the decade. Just 6% of borrowers with $100,000 or more in loans who left school between 2005 and 2006 defaulted on their debts five years later, per the NY Fed. More than 20% of borrowers who left school between 2010 and 2011 owing that amount defaulted within five years.

Over the past several years, higher education leaders have become most concerned about the fate of student loan borrowers with relatively low balances of about $10,000 or less. That’s because these borrowers are typically at the highest risk of defaulting on their debt, likely because their low balance is a signal that they didn’t complete much education.

Borrowers with six-figure debts, on the other hand, are less at risk of default because their high balances are often a sign that they’ve completed more schooling that’s made them valuable in the labor market.

Now it appears these borrowers are facing more challenges. While borrowers with high balances are still less likely to default than their counterparts with less debt, their default rates are catching up with the share of borrowers defaulting overall. The increased struggles of borrowers with six figure debts may reflect that it’s becoming more common to borrow $100,000 or more without getting a professional degree, like a medical degree, that typically assures good outcomes in the labor market.

In other words, $100,000 in student debt just doesn’t buy what it used to.

Financial Review

Rocket Science

Sinclair Noe — April 14, 2015

 

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DOW + 59 = 18,036
SPX + 3 = 2095
NAS – 10 = 4977
10 YR YLD – .04 = 1.90%
OIL + 1.38 = 53.29
GOLD – 6.10 = 1192.90
SILV – .13 = 16.23

For the past 3 months, retail sales have been down. There was some speculation that the harsh winter weather was to blame for declining sales; and that appears to be true. Retail sales rose in March for the first time since late last year as consumers stepped up purchases of automobiles and other goods. Retail sales increased 0.9 percent in March. That was the largest gain since March last year and snapped three straight months of declines.

In a separate report, the Labor Department said its producer price index for final demand increased 0.2 percent last month, with rising prices for goods accounting for more than half of the increase. The PPI, which measures prices at the wholesale level, had declined 0.5 percent in February.  In the 12 months through March, producer prices fell 0.8 percent, the biggest year-on-year decline since the revamped series started in 2009. Of course, the Federal Reserve has a 2 percent inflation target, so this data does not suggest the Fed needs to be in a hurry to raise rates.

The National Federation of Independent Business said its small-business optimism index fell 2.8 points to 95.2, the worst reading since June, with all 10 of its subcomponents declining. The biggest decline came in the percentage that say they expect better conditions in six months.

The U.S. ended the month of March with a budget deficit of $53 billion, up 43% from the same period last year, bringing the current fiscal year-to-date deficit to $439 billion at the end of last month. Meanwhile, Fitch has affirmed the U.S.’s long-term default ratings at “AAA,” citing the country’s “unparalleled” financing flexibility as the issuer of the world’s pre-eminent reserve currency and benchmark fixed-income asset. Fitch also expects the U.S. to grow 3% in 2015, before decelerating slightly in 2016.

The dollar’s strength almost perfectly tracks Fed statements about the coming end of easy money. The tightening of US monetary policy (or even the hint that policy will tighten at some point) has driven the dollar up (and oil down) even as Europe’s beginning of its own “QE” or quantitative easing program has driven the Euro down. None of it reflects the economic reality on the ground, but rather the fact that central bankers are, as investment guru Mohamed El-Erian frequently says, the “only game in town.”

A new study from the Berkeley Center for Labor Research and Education at the University of California finds nearly three-quarters of the people helped by public assistance programs actually goes to families headed by a worker; they just don’t make enough money to cover the basic expenses. Taxpayers pick up the difference between what employers pay and what is required to cover what most Americans consider essential living costs. The report estimates that state and federal governments spend more than $150 billion a year on four key antipoverty programs used by working families: Medicaid, Temporary Assistance for Needy Families, food stamps and the earned-income tax credit, which is specifically aimed at working families. As a result, taxpayers are providing not only support to the poor but also, in effect, a huge subsidy for employers of low-wage workers. A report issued last week by the Federal Reserve Bank of Cleveland said that labor’s share of overall income had fallen to record lows in recent years.

New research from the Federal Reserve Bank of St Louis shows nearly one in three Americans now paying down student debt are at least a month behind in their payments; that figure is far higher than official delinquency measures from the Education Department and the New York Fed. And it is probably more accurate because it looks at people who have started to pay and not all outstanding debt, which includes people who have not yet started repayment. It’s estimated there is now $1.3 trillion in student loan debt outstanding.

Greece is preparing to take the dramatic step of declaring a debt default unless it can reach a deal with its international creditors by the end of April. The Financial Times quotes a government official saying: “We have come to the end of the road…If the Europeans won’t release bailout cash, there is no alternative [to a default].” Athens has also decided to withhold €2.5 billion-euro of payments due to the IMF in May and June if an agreement is not struck.

The International Monetary Fund left its projection for global growth in 2015 unchanged from three months ago at 3.5 percent. According to the IMF’s World Economic Outlook, the global economy is being reshaped by swings in currency markets and the drop in oil prices. The strengthening dollar is boosting growth in the Eurozone and Japan while taking some steam out of the U.S. recovery. Both the euro and yen have declined against the dollar as the European Central Bank and Bank of Japan purchase assets to boost the supply of money in their economies. The IMF cut its US expansion forecast by 0.5 percentage point to 3.1 percent, still the fastest among major developed economies. The Japan growth outlook increased to 1 percent from 0.6 percent and the euro area is projected to expand 1.5 percent as weakening currencies provide a boost. The figures show India will grow more quickly this year than China for the first time since 1999. The IMF predicts India will expand at a 7.5 percent rate. China is expected to grow 6.8 percent this year. Brazil will contract 1 percent in 2015.

One of the more important points of the IMF report is that potential output is growing more slowly than before. So, the takeaway is that the global economy is characterized by weak investment, low real and nominal interest rates, credit bubbles and unsustainable debt. Any solution sounds a bit circular, and largely deals with tweaking interest rates one way or another, while avoiding the real questions of increasing sustainable growth and reducing instability. Thanks IMF.

The race for renewable energy has passed a turning point. The world is now adding more capacity for renewable power each year than coal, natural gas, and oil combined. And there’s no going back. The shift occurred in 2013, when the world added 143 gigawatts of renewable electricity capacity, compared with 141 gigawatts in new plants that burn fossil fuels. According to an analysis presented at the Bloomberg New Energy Finance annual summit in New York, the shift will continue to accelerate, and by 2030 more than four times as much renewable capacity will be added.

The price of wind and solar power continues to plummet, and is now on par or cheaper than grid electricity in many areas of the world. Solar, the newest major source of energy in the mix, makes up less than 1 percent of the electricity market today but will be the world’s biggest single source by 2050.

Earnings reporting season kicks into high gear. JPMorgan Chase posted stronger-than-expected earnings growth, helped by a rebound in fixed-income trading. Revenue rose 5 percent. Wells Fargo reported first-quarter earnings that topped expectations. Wells Fargo said low interest rates pushed first-quarter lending margins below 3 percent for the first time since the 1990s. Johnson & Johnson reported adjusted earnings that topped expectations, but the consumer products giant also cut its full-year forecast, citing the impact of a strong dollar. Late Monday, Norfolk Southern forecast a surprise drop in its first-quarter earnings and revenue. Intel reported a 3% growth in first-quarter earnings on flat revenue growth as the semiconductor giant was hurt by softer demand for personal computers and impacts from a stronger dollar. For 2015, Intel said it now expects revenue to be flat from a year ago.

Cyberattacks and cybercrime against large companies – those with over 2,500 employees – rose 40% globally in 2014, according to Symantec’s annual Internet Security Threat study published Tuesday. Attacks on small- and medium-sized companies, which accounted for 60% of targeted attacks, increased 26% and 30%, respectively. Despite the large hacks at Home Depot, JPMorgan, Staples and Sony, Symantec says the mining industry, which includes oil & gas, was the most-targeted sector last year.

Nokia is in talks to buy smaller telecom equipment maker Alcatel-Lucent in a deal that would combine the industry’s two weakest players. In a joint announcement, the Finnish and French companies said they were in “advanced discussions” on a “full combination, which would take the form of a public exchange offer by Nokia for Alcatel-Lucent.” The two, which have been seen as a possible combination for the last several years, cautioned that the discussions could still fall apart. The pair are a good fit in terms of products and geographies, and bulking up would help them cut costs as they try to compete with much larger competitors in the mobile market.

Amazon and HarperCollins have reached a new multi-year publishing deal – expected to go into effect this week – that covers both print and digital titles. The agreement calls for HarperCollins to set the retail prices of its digital books, with incentives for HarperCollins to provide lower prices to consumers. In November, Amazon ended its brutal battle with Hachette over print and e-books, following a six month stand-off that battered the French-owned publisher’s sales.

United Launch Alliance, a joint venture of Lockheed Martin and Boeing, has unveiled a reusable rocket named “Vulcan” that is slated to take off in 2019 and end US dependence on Russian-built rocket engines. Russian-made RD-180 engines currently power ULA’s Atlas rocket, but Congress has banned further imports as part of trade sanctions enacted after Russia invaded Ukraine last year. Vulcan’s reusable engines are likely to slash satellite-launch costs and provide a stepping-stone to various commercial space ventures.

Space X has been working on a reusable rocket, the Falcon 9. After bad weather yesterday forced a delay, the Falcon successfully launched today, and will delivered its cargo to the International Space Station; the reusable part of the rocket then landed on a floating platform in the Atlantic Ocean, but it came in a little hot and the 140 foot tall rocket tipped over and fell into the water. Turns out rocket science is difficult after all.

Thursday, August 14, 2014 - The Circular Capex Spending Problem

Financial Review with Sinclair Noe

DOW + 61 = 16,713
SPX + 8 = 1955
NAS + 18 = 4453
10 YR YLD - .01 = 2.40%
OIL - .39 = 97.20
GOLD + .70 = 1313.90
SILV + .05 = 19.95

Iraqi Prime Minister Nouri al-Maliki stepped down today, a surprising reversal for a prime minister who a day earlier had assured his supporters that he wouldn’t step down unless forced out by Iraq’s high court.

President Obama says the US operations have broken the ISIS siege of Mount Sinjar. Thousands of Yazidi refugees were stranded on the mountain. Many of those displaced had now left the mountain and further rescue operations are not planned, however US airstrikes against ISIS will continue for now. And Iraqi and Kurdish forces fighting ISIS will continue to receive US military assistance.

Russian President Vladimir Putin said Russia would stand up for itself but not at the cost of confrontation with the outside world, which sounded like a softer, gentler Putin. Trust him about as far as you can throw him. Intense fighting continues as the Ukrainian military kept up its offensive to retake separatist strongholds in Eastern Ukraine.

A new, five-day truce between Israel and Hamas appeared to be holding despite a shaky start, after both sides agreed to give Egyptian-brokered peace negotiations more time. The second extension of the ceasefire, this time for five days rather than three, has raised hopes that a longer-term resolution to the conflict can be found; maybe.

The Missouri State Highway Patrol will take over the supervision of security in the St. Louis suburb that's been the scene of violent protests since a police officer fatally shot an unarmed black teenager.

Earnings season continued to wind down. WalMart reported earnings and revenue that met expectations, but the company cut its forecast for coming quarters. Last night, Cisco Systems offered a weak outlook for its current quarter and announced massive job cuts despite reporting revenue that beat expectations.

We’ve all heard of jobs offshoring; US jobs that once built the world’s biggest middle class, have been sent overseas, and it’s been going on for quite some time. The idea was heralded as free trade globalism and the argument was that it was merely mutually beneficial free trade; but American jobs have been lost and continue to be lost, not to competition from foreign companies, but to multinational corporations that are cutting costs by shifting operations to low-wage countries.

One result of offshoring is lower labor costs, but that also means lower wages. University graduates in the US are just as likely to be employed as bartenders or baristas as they are to get a job as a software engineer of plant manager. And there’s a good chance that recent grads are still living at home with their parents. More than half with student loans are having a hard time paying down student loan debt; 18% are either in collection or delinquent; another 34% have student loans in deferment or forbearance. And if they do find jobs, they find those jobs don’t pay well. Wages have stagnated.

Even though the economy has been adding jobs, it has not been enough to push a recovery in wages. In July, average hourly wages rose a penny to $24.45, a disappointing result after strong gains in June and May. In 23 of the past 24 months, the yearly increase in hourly pay has ranged from 1.9% to 2.2%, or about one-third less than usual during an economic recovery. The 12-month increase in wages as of July was just 2%; and inflation wiped out about three-fourths of that gain. There’s been no change since the start of 2014. While it might seem counterintuitive that wages are flat while jobs are being added, the likely reason is that there are a lot of poor paying jobs plus a few very good paying jobs. According to revised data from the Commerce Department, employee compensation, including wages and benefits, was lower for each year from 2011 to 2013 than previously calculated.

Jobs off-shoring, by lowering labor costs and increasing corporate profits, has enriched corporate executives and large shareholders, but the loss of millions of well-paying jobs has made millions of Americans downwardly mobile. Between October 2008 and July 2014 the working age population grew by 13.4 million persons, but the US labor force grew by only 1.1 million. In other words, the unemployment rate among the increase in the working age population during the past six years is 91%. Since the year 2000, the lack of jobs has caused the labor force participation rate to fall, and since quantitative easing began in 2008, the decline in the labor force participation rate has accelerated. Clearly there is no economic recovery when participation in the labor force collapses. In addition, jobs off-shoring has destroyed the growth in consumer demand on which the US economy depends with the result that the economy cannot create enough jobs to keep up with the growth of the labor force.

Some people argue that the problem with economic growth doesn’t start with wages and jobs, but rather with credit, and they point to graphs of the recent rise in auto loans; just as mortgages once fueled a housing boom, now, subprime lending is fueling a boom in auto sales. Credit tightened in the wake of the housing collapse and the housing market remains weak, while auto lenders have become aggressively permissive and US auto sales have made a huge recovery, leading some to argue that consumption depends on access to credit. This is wrong. Access to credit is the lubricant for the engine of economic commerce; it is not the engine. The real driver of the economy is good paying jobs.

There have been magnificent innovations in transportation, medicine, communication, and technology as commerce has spread globally. Credit did not create technological advances, people did. Money and credit could always be used to purchase the tools to make money in business, but money could never produce anything by itself; food, clothing, shelter, cars, and thousands of other worthwhile things were always made by the labor of people, not the sweat and intelligence of a coin or a plastic credit card.

The Federal Reserve just released a report showing that two-thirds of American households have no savings set aside for an emergency, and 40% are unable to raise $400 cash without selling possessions or borrowing from family and friends. Offshoring, by lowering labor costs and increasing corporate profits, has enriched corporate executives and large shareholders, but the loss of millions of well-paying jobs has made millions of Americans downwardly mobile. In addition, jobs off-shoring has destroyed the growth in consumer demand on which the US economy depends for expansion. Corporations are borrowing money not to invest for the future but to buy back their own stocks, thus pushing up share prices.

A new report from Morgan Stanley shows the average age of industrial equipment in the US is now almost 10.5 year old. That’s the oldest since 1938, at the height of the Great Depression. Nonresidential capital expenditure; in other words, spending on equipment, nonresidential buildings like factories, and intellectual property, has fallen short of the long-term trend by 15% per year. That means businesses have pumped into the economy $400 billion less than they normally would have every year. That's $1.6 trillion over the past four years, and it's affecting every sector. Spending has been down 14% on buildings, 16% on equipment, and 6% on intellectual property.

Instead of investing that money, corporations have been hoarding cash; by some estimates, corporations are sitting on a pile of almost $2 trillion. Occasionally they dip in for share buybacks. S&P 500 companies bought back an estimated $160 billion in stock in the first quarter; that would lag only the $172 billion in the third quarter of 2007, shortly before the worst bear market since the Great Depression. Repurchases are all the rage, but are all too often made for an unstated and ignoble reason: to pump or support the stock price. Another corporate incentive for buybacks is that a pumped-up share prices make the stock grants and options held by senior executives more valuable. Occasionally they dip into the cash pile for mergers and acquisitions. North American M&A activity stands at $1.2 trillion year to date, up 83% from last year. This year is almost certain to be the best year for M&A since the crisis. Boosting growth and returns through long-term investment in their business hasn't registered nearly as highly.

The problem then becomes circular: weak demand holds back capital expenditures, which drags on growth, which depresses demand. Productivity growth in the United States, the rate of growth in the level of output per worker, is near a 30 year low. Spending on research, development and technology, would surely improve this trend. Productivity alone does not spur capex spending. Rather, spending increases when demand increases. You don’t buy a new factory or new equipment unless your customers are spending. However if your customers are spending, you will happily invest in the facilities to fill their orders. But real median household income fell 10% between 2007 and 2012. And since the financial crisis, demand across the US economy as a whole has been far below trend.

Several of America’s great cities, such as Detroit, Cleveland, St. Louis have lost between one-fifth and one-half of their populations. Real median family income has been declining for years, an indication that the ladders of upward mobility that made America the “opportunity society” have been dismantled. So, now we face a tipping point, where we either start to reinvest in industrial production or watch the infrastructure turn to rust, and the US becomes a third world country.

The good news is that we are making progress in some areas. We add jobs every month, more than 200,000 jobs per month for the past six months. Capacity utilization is now up to 79%. US exports now top $2 trillion, the highest level in history. Despite the numerous false dawns since the Great Recession, analysts still expect capex to pick up. If it does, then the broader economy should benefit. Factories and equipment will have to be replaced, eventually. It might represent an opportunity; if we’re lucky.